Guitar holders like acquisition; Coltec up; Protein Design seen re-priced, trades light at 98

By Ronda Fears

Nashville, Feb. 10 - Convertibles were a little softer again Thursday, although stocks managed to eke out small gains on the day. But, despite ongoing chatter about withdrawals from the convertible market by hedge funds, traders said it wasn't like the market was for sale, either.

Rather, in addition to still seeing some convertible players cross over to buy junk bonds like those of Mercer International Inc., traders Thursday remarked of new crossover buyers for converts - specifically mentioning Level 3 Communications Inc., Charter Communications Inc. and Amkor Technology Inc.

Treasury yields were beginning to counter the recent rally in bonds showing a backup in yields Thursday on profit-taking, which some onlookers from the convertible market suggest could continue. And some isolated spread widening, such as a slight move in Goodrich Corp., enticed some buying.

Protein Design Labs Inc. also managed to find a trade for its newest convertible, the 2.0%, up 30% deal that priced wide of yield guidance for a 1.25% to 1.75% coupon and at the cheap end of premium talk of 30% to 35%. A buysider said he got involved in the issue as it got re-priced below par. Then, he said, it traded "a little and then nothing." A sellside shop involved with the deal reported, though, they were "still not seeing any flow in the new PDLI deal." The issue was last seen at 98, the buysider said.

Huntsman Corp. now is due to break for trading Friday after the initial public offering of stock prices late Thursday. The $250 million three-year mandatory convertible is talked at a 5.0% to 5.5% dividend and 18% to 22% initial conversion premium. It is scheduled to price alongside the Salt Lake City-based chemical company's IPO of 55.7 million shares talked in a range of $21 to $23 a share, which Wall Street analysts predict to be discounted to the area of $19 a share.

With merger and acquisition activity still keeping convertible players in a state of angst, Guitar Centers Inc.'s earnings and an acquisition of its own pleased those convert holders. And, the Goodrich play was a takeover situation, as well, one buyer said.

Thus far, most of the M&A attention has been on convertible issuers as targets rather than as suitors and anxiety levels were not aided by a Lehman Brothers Inc. report Thursday warning that the anti-takeover language in most new deals of late will not necessarily protect convertible holders.

Guitar 4% issue up 2-3 points

On the heels of Guitar Center announcing whopping earnings, which also beat the company's raised guidance, plus an immediately accretive all-cash acquisition, its 4% convertible shot up 2 to 3 points on Thursday.

Guitar Center on Wednesday posted a 38% gain in fourth-quarter profits, although its earnings per share was impacted by a reduction required as a result of the new accounting rule on dilution from convertible issues on an if-converted basis, and the company issued guidance for a strong first quarter.

The Westlake Village, Calif.-based guitar retailer also said it would buy Music & Arts Center, a Maryland-based retailer of band instruments to schools and mainstream consumers, for about $90 million, plus the assumption of about $8 million in debt. The deal is expected to add to 2005 earnings, and Guitar Center noted that Music & Arts most recently showed $80 million in annual sales.

Guitar Center sees first-quarter earnings per share in a range of 48 cents to 52 cents with sales of $360.6 million to $399 million.

A holder of the Guitar Center convert said he was pleased with the transaction and the company's earnings.

"We bought in [the convert] in late September at 142.5 and they are at 178.5 today, so we're happy," he said. The Music & Arts Center acquisition seems smart, he added, since it will not be a huge drain on Guitar Center's resources - a $150 million line of credit, $3.8 million in short-term marketable securities and $17 million in long-term marketable securities.

Coltec 5.25s gain 0.25 points

For the most part, though, convertible players have been anxious about targets in ConvertWorld and the way-laying impact of cash takeovers. Goodrich is considered to be a target in the aerospace and defense sector, but with the stock considered expensive the convertible attached by virtue of the acquisition of Coltec Industries Ltd. looks cheap.

Goodrich shares were easier Thursday, edging off 8 cents to $35.77, after the company earlier this week posted better-than-expected results. The Coltec 5.25% convertible trust preferreds, however, shot up 0.25 point to 49.125 on the purchase of a big block, a buyside source said.

"As a point of interest," the convert holder pointed out, "Goodrich purchased Coltec Industries, which in November was awarded by a federal claims court judge to get a federal tax REFUND of $82 million plus interest (totaling approximately $30 million) for a grand total of $112 million. Ninety days has just elapsed. IF the federal government does not appeal, Goodrich already has netted 65% of last year's total earnings ($172 million)!"

A convertible dealer said, "All I can figure right now is guidance for 2005 is good [for Goodrich]. Boeing keeps saying they will deliver more jets than earlier thought and that there were two news stories concerning military spending saying it will stay fairly strong, and the commercial market is gaining momentum after a long downturn."

The buysider also said that although Goodrich is considered a takeover target, it is probably considered an expensive one based on where the stock is trading, so the below par convertible is even more attractive.

Goodrich credit default swaps showed some cheapening, too, "maybe 5 bps or so," he added, after getting highlighted in a Merrill Lynch report earlier this week. Merrill Lynch analyst Brian Zinser said in a report Tuesday that Goodrich's swaps look more attractive relative to its bonds, but he said he is keeping a marketweight rating on both.

Level 3, Charter, Amkor eyed

On a capital structure trade, convertible market watchers noticed Thursday that there were crossover buyers from JunkLand buying Level 3, Charter and Amkor converts.

For the third consecutive session, Level 3 paper - convertibles and straight junk bonds - has been slipping along with the stock. While earlier this week Level 3 reported a narrower net loss, the company's tightened guidance shook up bondholders.

By Thursday, a sellside trader said the Level 3 converts were down by about 10 points for the week. The stock on Thursday fell nearly 16%, or 36 cents, to $1.90.

Charter's new 5.875% convertible was the focus in that name, the trader said, and it was pushed about a quarter-point higher on the purchasing. Amkor's 5% converts due 2007 also were higher about a quarter-point, he said, while its 5.75% due 2006 was off about a half-point.

Junk paper also lures players

Difficulty in the primary market is not exclusive to convertibles, as particularly of note junk bond deals have been on the decline. But there is still more volume on the high-yield calendar, and that has been luring convertible players.

Amid a lighter pace of new issues, Mercer provided the biggest junk bond deal Wednesday as the pulp producer priced an upsized $310 million issue of eight-year senior notes to yield 9.25%, at the wide end of talk of a 9% to 9.25% handle.

"We got bonds on the deal and are buying more. We bought some right after the deal at 101," said a Mercer 8.5% convert holder, referring to participating in the Mercer junk bond.

There was little to no impact to the Mercer convert, however, he said. He pegged the 8.5s due 2010, a small $82.5 million issue, at 125.5 to 126.5 with the underlying stock at $8.83, where it closed.

Some shops focus on outrights

In general, market chatter still suggests the redemptions are for real, that hedge funds are pulling up stakes in convertibles, but there has been no concrete evidence thereof.

"We heard a 'sizable' - whatever that means - fund just rolled out of all their convertible positions, they didn't shut the doors completely," said a sellside desk analyst.

That is everyday noise for the market lately, but another sellside convert analyst said that as a result his desk is focusing on the outright convertible investors.

"As to what's interesting in ConvertLand, there have been some departures/cuts/desk closures recently in the convert arb world," he said. "I'm not really in a position to say who or where because I only heard it discussed in passing. Some fairly well-known shops, though. I don't know the extent of it."

The problem obviously extends beyond convertibles, he added, to any market that hedge funds, specifically market-neutral funds, touch, along with any other players that use hedging techniques on a large scale. Low volatility and tightened credit spreads have been exacerbated by the influx of liquidity, and generally made it impossible to earn decent returns on capital.

"Not enough capital has left those segments of the market. We all keep waiting for a big event that causes a bigger shakeout, but I just don't see it happening unless institutions pull capital from the hedgies on a grand scale," the analyst said.

"In the meantime, we've shifted our attention back to the outright players."

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